Portfolio Pugilism

What do boxers have to do with portfolio construction?

One of the key challenges to wealth creation is portfolio construction. Its a topic which is usually kept on the back burner while the investor focuses on stock selection. But this is of critical importance right from the word go.

Another pursuit of amateur investors is to focus on only one type of portfolio. Again this in my humble opinion is not a suitable approach.

So what should we do? We should think and act like a boxer.

He who is not courageous enough to take risks will accomplish nothing in life.

Muhammad Ali

The Attack

A boxer has only 4 major types of punches in his attacking arsenal.

1. The Left Jab
2. The Right Cross
3. The Uppercuts
4. And the lethal Left Hook

Similarly a portfolio should consist of 4 distinct sub portfolios.

1. The Compounders aka The Left Jab
2. The Trackers aka The Right Cross
3. The Bets aka The Uppercuts
4. The Core Core aka The Left Hook

Lets look at some salient features of each type of portfolio.

The Compounders aka The Left Jab

The Left Jab is perhaps the most safest way to fend of your opponent with an attack. The longer the reach of a boxer’s arm the better it is. They require lesser energy to execute. For a Compounder portfolio an investor needs to have a solid set of high and consistent return on capital generating businesses with stable earnings growth. Like the Jab these fend off the bad macro times and keep one’s equity portfolio relatively stable. In my opinion 10–15 businesses usually should form the foundation of the Compounders.

The Trackers aka The Right Cross

To execute a Right Cross you need to be closer to your opponent than the Jab. There is risk of counter-punch but the move is worth the risk to set off a flurry of other attacks. Similarly the Tracker portfolio are businesses which an investor tracks in smaller quantities. The attack can be to increase capital allocation to these businesses if the situation demands or reduce it in other cases. The number of businesses in this portfolio could be long with very low allocation.

The Bets aka The Uppercuts

The left and the right Uppercuts are effective tools which comes at a high risk because the boxer is closest to the opponent. These punches set off a combination attack on the opponent. Likewise the Bets are those businesses you hold which could be either cyclicals or being assisted by some tailwinds. They could be high on risk if you got them wrong just like the uppercuts.

The Core Core aka The Lethal Left Hook

The Left Hook is the most lethal punch in a boxer’s attacking tool kit. Tremendous amounts of torque from the feet and hip are generated to knock off the opponent. The Core Core is a portfolio of the best bets an investor has. This portfolio ideally should be able to generate the highest CAGR over time.

Relationship between the 4 sub portfolios

Just like growth share matrix in which a business moves across 4 segments of the matrix similarly a business should move across these sub portfolios (could be back and forth too). A business which is in the Trackers portfolio moves either out of an investor’s overall portfolio or into the Core Core. An ideal exit from the Core Core is the Compounders but it could also go back into the Tracker. A business from the Bets portfolio usually moves out completely else it would have perhaps been in the Trackers portfolio. The end game for a business after starting off from either the Tracker or the Bets portfolio is to move to the Core Core and from thereon to the Compounders. The way back is also similar.

No business should enter the Compounders or the Core Core before going through the Tracker or the Bets portfolio in my opinion.

If we think the usual number of businesses and capital allocation could be broadly outlined as below:

1. The Tracker: As many businesses you can analyze — minimal capital allocation — CAGR not critical as we are here to get our stock pick right
2. The Bets: Fewer than 5 usually — sub 20% capital allocation — CAGR of over 10%–15%
3. The Core Core: Fewer than 10 usually — 40% capital allocation — CAGR of over 20%
4. The Compounders: Not more than 15 — 40% capital allocation — CAGR of 15%-20%

These are very arbitrary numbers but you do get a sense of the compositions. Following more than 30 businesses is a very tough ask. Therefore it is natural to have as minimum number of companies as possible to know the nuances and follow the micro events related to them.

The Defense

Attacking is only perhaps a quarter of the sport of boxing. It is the defensive moves and stamina which constitutes the remaining 80%. A boxer ducks, bobs & weaves, feigns attacks and counter attacks when the opponent is coming down strong on him or her. In the investing parlance if there are macro headwinds, or micro unknowns (will avoid the word black swan)it is the fixed income or rather the liquidity in the investor’s portfolio which creates a cushion and gives purchasing power. As an investor one should always hold 10%–20% liquid funds earning a safe 6%-7%. The most important trait is the ability to last the grueling 10 rounds for a boxer. Similarly the investor needs to lengthen his stay in the capital markets as long as possible. This is the key to long term wealth generation. Don’t get wiped out. Don’t.

Most of the investors set out for a >25% CAGR target. I think this is the wrong way to approach investment. In my opinion 2 broad tenets should govern this mindset:

1. Protect the downside: As Nassim Taleb says “Lesson 101 in Tail Risk management is to work backwards: First, figure out exactly what would ruin you, then eliminate/mitigate. It’s the modus operandi of investors eg Warren Buffett….all survivors. And Stalin/Mafia chiefs: find out who could wack you & preempt.”
2. Be realistic & patient: It is better to have a goal of 14% CAGR over 30 years than to have a 30% CAGR over 14 years.

I am not a believer of fire and forget aka the Coffee Can. In this strategy there is more reliance on the almighty than to one’s own skill and hard work.

And last but not the least. Muhammad Ali, Joe Frazier, George Foreman, Rocky Marciano, Sugar Ray and all other greats put in more time doing roadwork, heavy bag and sparring than the minutes in the ring. Work hard and practice. Work hard.

The fight is won or lost far away from witnesses — behind the lines, in the gym, and out there on the road, long before I dance under those lights.

Muhammad Ali

All the best to your portfolio construction!